This is the story of what happens when you gamble—and lose. When you get reasonable advice—and ignore it. And when one smallish decision cascades into a bet-the-company one.

In 2001 Dan Ustian, then head of Navistar International’s diesel engine unit, faced a slew of new air quality regulations from the Environmental Protection Agency. More stringent engine standards were already set to take effect three years hence, and the EPA was now requiring at least a 90% reduction in the amount of nitrogen oxides and soot emanating from diesel engines. Even diesel fuel itself was being reformulated to cut down on its sulfur content.

The new rules meant that Navistar, as well as rivals like Volvo, Mack, Freightliner,
Paccar and
Cummins, would have to redesign all their engines for American roads, using technologies that were less than perfect or inventing new ones. EPA estimated the cost of compliance, including the new fuel, would be substantial: $4.2 billion. But engine makers would have plenty of time to adapt. The new standards wouldn’t even begin to be phased in until 2007, with full implementation slated for 2010.

Ustian had several engineering paths available, including the use of nitrogen oxide adsorbers (“traps”) or a chemical treatment system called selective catalytic reduction, which European rivals favored. But neither was yet capable of achieving the eventual EPA requirements—they’d need further engineering development.

Ustian, then in his early 50s, was Navistar’s rising star—a professional manager, rather than an engineer, he would soon be promoted to president and then chief executive. Rather than following rivals with SCR, he decided, fatefully, to go with his gut. He figured truckers didn’t want to bother with an extra tank of fluid aftertreatment, so Ustian staked $700 million—and the fate of the company—on further advancing an existing diesel engine technology called exhaust gas recirculation (EGR). Rather than eliminate nitrogen oxide via a bulky chemical treatment system that even the EPA questioned initially, EGR would make the motor do all the work by piping exhaust gas back into the cylinders and burning it again—a cleaner, cheaper, lower-maintenance solution, which would set Navistar ahead of the pack. “Our ability to achieve our goals without adding customer cost and inconvenience is a competitive advantage,” Ustian told investors in late 2007.

All his engineers would have to do is perfect it.

That decision is now proving catastrophic. As the project developed and 2007 turned into 2008 and 2009 it became increasingly obvious—to everyone but the CEO, says one former manager who was close to Ustian—that Navistar had done worse than pick the diesel version of Betamax when the rest of the world was going to VHS. It simply couldn’t get its engines to work as hoped. “Dan is telling his technical people, ‘You’ve got to deliver,’ and they’re saying, ‘We don’t know how, but we’ll try,’” says the former executive. “There was a lot of tension in the technical community, from the scientists on up to the managers, about whether we should be agreeing to something we don’t know how to do. Dan didn’t want to hear any of it. ‘You’re going to get it done.’ He’s a positive thinker. He doesn’t like negative thinking.”

Now, two and a half years past the deadline for compliance, Navistar’s engine still isn’t clean enough to pass the EPA’s emissions test. On July 6, after an appeals court rejected an EPA compromise that allowed Navistar to keep selling its noncompliant engines with offsetting penalties, Ustian made an about-face, reluctantly embracing the very technology he had spurned for years.

The strategy reversal was more than just an embarrassment to Ustian, who spent years deriding his competitors’ approach, even suing the EPA and pushing for a recall of their engines (neither of which was successful). It could also mean the collapse of the company.

Its pretax loss in the first half of 2012 was $516 million on revenues of $6.4 billion as new truck sales stalled out and quality problems on its earlier engines required Navistar to boost its warranty reserves by $227 million. More alarming, perhaps, future orders plummeted 40% in the second quarter, making promised market share gains highly unlikely. Navistar shares have been punished, down more than 50% in the last 12 months. The Illinois-based company, which did more than $14 billion in sales last year, now has a market cap of around $1.6 billion.